Internal Generated Goodwill

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Querist : Anonymous

Querist : Anonymous (Querist)

27 April 2011 Can anyone explain me the reasons for not recognizing internal generated good will?

Mandar

Mandar (Expert)
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28 April 2011 Internally generated intangible assets

If views are quite unanimous that the accounting treatment for purchased intangible assets should be similar to that for tangible assets, many commentators on the Exposure Drafts were opposed to the concept that an enterprise should recognize a self-constructed intangible asset when the recognition criteria were met. These opponents include:

users of financial statements. They are usually suspicious of the types of internally generated intangible assets that are recognized in the balance sheet. They also believe that it is not possible to assess reliably the amount that can be recovered from intangible assets, unless its value can be determined by reference to an active market. Therefore, they believe that recognizing a self-constructed intangible asset for which no active market exists at an amount other than zero may mislead investors;
those who have concerns that IAS 38 s definition of, and recognition criteria for, an intangible asset - which require management and auditors to exercise judgement - are too subjective and will undermine the comparability of financial statements; and
those who believe that IAS 38 s requirements will result in very little decision-useful or predictive information when applied to internally generated intangible assets. This is because they believe that, in most cases, the cost of a self-constructed intangible asset recognized in the balance sheet will not represent the total expenditure on that asset: demonstration of technological feasibility or commercial success (required to meet the recognition criteria) will generally not be achieved until substantial expenditure has been recognized as an expense. Therefore, they believe that it is not worth recognizing only part of the cost of an internally generated intangible asset.

Querist : Anonymous

Querist : Anonymous (Querist)

28 April 2011 Hi,
If u dont mind,kindly explian me why Internally generated goodwill is not accounted in the books of accounts,as per indian accouting standards?
My doubt is when we are incurring some expenditure in the form of advertisment and some other expenditure to earn goodwill for the enterprise in such case why we are not allowing us to recognize such internally generated goodwill in the books of accounts?

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Asha Kanta Sharma

Asha Kanta Sharma

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01 August 2024 ### Why Internally Generated Goodwill is Not Recognized in Financial Statements

**1. **Nature of Goodwill:**
- **Goodwill Definition:** Goodwill represents the excess value paid over the fair value of identifiable net assets during the acquisition of a business. It reflects factors such as brand reputation, customer loyalty, and business relationships that are not separately identifiable.
- **Internally Generated Goodwill:** This refers to the value created internally by a company's own efforts, such as through advertising, marketing, or other activities that enhance the company's reputation or customer base.

**2. **Accounting Standards and Principles:**
- **Indian Accounting Standards (Ind AS) and International Financial Reporting Standards (IFRS):** Both sets of standards (Ind AS 38 - Intangible Assets and IFRS 38) do not allow for the recognition of internally generated goodwill. This is primarily due to issues with reliability and measurability.

- **Historical Cost Principle:** The accounting standards require assets to be recognized at their cost, which includes all costs incurred to acquire and prepare the asset for its intended use. Internally generated goodwill does not have a direct cost associated with its creation and is thus not recognized as an asset.

**3. **Measurability and Objectivity:**
- **Difficulty in Measurement:** Internally generated goodwill is inherently subjective and challenging to measure reliably. Unlike purchased goodwill, which is based on an actual transaction and can be measured based on the purchase price, internally generated goodwill lacks a clear and objective measurement basis.

- **Lack of Reliable Data:** The benefits derived from advertising, marketing, or other activities contributing to goodwill are often uncertain and may not directly translate into measurable economic benefits. This makes it difficult to quantify and assign a reliable value to internally generated goodwill.

**4. **Consistency and Comparability:**
- **Consistency:** Allowing the recognition of internally generated goodwill could lead to inconsistencies in financial reporting, as different entities might value their internally generated goodwill differently.

- **Comparability:** Excluding internally generated goodwill ensures that financial statements remain comparable across entities and time periods. This enhances the reliability and relevance of financial information for investors and stakeholders.

**5. **Accounting Treatment of Related Expenditures:**
- **Advertising and Marketing Expenses:** Expenditures on advertising and marketing are typically expensed in the period they are incurred. While these expenditures may contribute to the company's reputation and customer base, they do not create an identifiable asset that can be recognized on the balance sheet.

- **Intangible Assets:** Intangible assets like patents, trademarks, and copyrights can be recognized if they are acquired externally and have a measurable cost. Internally generated goodwill does not fit this criterion.

**In Summary:**
Internally generated goodwill is not recognized in financial statements due to the difficulties in measuring its value reliably, the subjective nature of its creation, and the need to maintain consistency and comparability in financial reporting. Expenditures that contribute to goodwill, such as advertising and marketing, are typically expensed as incurred, reflecting the immediate benefit rather than creating a recognizable asset.